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Diamonds And Dirt

August 09, 1992

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DIAMONDS AND DIRT

John F. Welch Jr., chairman of General Electric Co., fought one fire when he testified before a House Energy & Commerce subcommittee on July 29. Welch tried to bring to a close the saga of GE's Aircraft Engines Div. falsely billing the U.S. for military sales to Israel during the 1980s. Employees in the engine unit had worked with Rami Dotan, a now-imprisoned former Israeli general, to divert military aid money illegally. GE pleaded guilty to four felonies and agreed to pay $69 million to settle civil and criminal charges.

But Welch has another blaze at his back. GE also is grappling with charges that it fixed prices of industrial diamonds, parked stock with Japan's Mitsui & Co., and engaged in a host of anticompetitive and unethical practices related to its synthetic diamond unit, GE Superabrasives, located near Columbus, Ohio. The diamond charges, first aired in a wrongful discharge suit filed in U.S. District Court in Cincinnati by former GE Vice-President and GES General Manager Edward J. Russell, now are under investigation by a federal grand jury in Columbus. The suit alleges misconduct by high-ranking GE officials.

PALACE REVOLT. GE derides Russell's claims. Welch himself has called them "pure nonsense." A company spokeswoman calls them "unsubstantiated allegations by someone removed for poor performance." One GE lawyer told the court in Cincinnati: "He never blew any whistles at all, and we think we can prove it. Even if he did, he wasn't fired for it."

GE's defense in the Cincinnati case is marked by aggressive attempts to discredit Russell. The company claims that Russell's poor management led to an uprising among his staff. It even contends that his wife, a former GES employee, was improperly asked to make key business decisions. Russell says such contentions are mostly fanciful.

While the suit could still be dismissed, the judge in the case on July 13 denied requests for a stay and set Feb. 21, 1994, as a trial date. GE wants the trial to focus on the question of whether Russell was wrongfully fired. It is conducting an internal investigation of his charges and says that a point-by-point response to them will come before the proper audience: the grand jury.

The problem for GE is that even if its trial strategy works, Russell has raised serious issues that now figure to drag on. "I think this is going to stay around for a while," says an official at a rival diamond maker.

For now, anyway, sources close to GE say it's spending in the neighborhood of $1 million a month to fight off the lawsuits that have proliferated as a result. They now include at least three shareholder suits and an equal number of class actions filed by customers. But the federal grand jury investigation is the most worrisome for GE.

LONG LIST. The panel is probing both the stock-parking and price-fixing allegations. It has issued a 28-page subpoena that has GE tracking down documents in Frankfurt, Singapore, and Tokyo. By mid-June, the grand jury had asked for "hundreds of thousands of documents," according to GE attorney Irvin B. Nathan of the Washington firm Arnold & Porter.

More potentially damaging than the documents, though, is Russell, who is working with federal investigators. Russell is given to looking up notes from old conversations in a green spiral notebook that he carries around with him. What's more, Russell says that while at GES, he taped some of his conversations, a practice that's legal in Ohio. As one source close to the investigation puts it: "It's obvious he was a notetaker."

GE seems up for a fight. In June, a lawyer at Arnold & Porter called Alison Pfeister, Russell's ex-wife, who divorced him seven years ago. Asked to explain the call, a GE spokesman answers: "I leave it to your imagination." Pfeister, a lawyer, says: "If this is a business suit, I'm not sure as an ex-wife I should be called to dig up dirt."

Russell has a long way to go to prove his charges. But some of them, at least, can't simply be dismissed as the grumblings of a vengeful ex-employee. His suit claims, for instance, that GE Plastics sold its stake in Asahi Diamond Industrial Co. to Mitsui to pump up 1989 earnings. But GE, says Russell, didn't intend actually to relinquish control of the shares. So, says Russell's suit, GE agreed to repurchase the stock later at the original sale price and pay Mitsui's carrying costs. Such an agreement could be construed as illegal stock-parking, legal experts say.

Mitsui had no comment except to acknowledge that a Mitsui manager sent a letter, of which BUSINESS WEEK has a copy, to GE Plastics outlining the terms of the stock deal. The Mitsui letter could be construed as supporting Russell's charge that GES wanted to buy the shares back but that GE's accounting department objected to the arrangement. GE flatly denies the whole sequence of events Russell describes. Russell's gravest charge--that GE fixed the prices of synthetic diamonds--is given credence by some industry players. These sources point to the history of the business since GE first developed synthetic diamonds in the mid-1950s.

The industrial diamond business has always been secretive and highly concentrated. Together, GE and South Africa's De Beers Consolidated Mines Ltd. control at least 80% of this $600 million business, according to users of industrial diamonds. Each did especially well on what are known as saw-grade diamonds, so named because they are used in saws that cut rock and concrete.

As Russell tells it, his boss, then-GE Plastics Chief and Senior Vice-President Glen H. Hiner, now CEO of Owens-Corning Fiberglas Corp., started meeting with De Beers in 1989. GE acknowledges in court papers that Hiner met withDe Beers personnel during the 1989-91 period. Russell argues that Hiner was desperate to pump up the profits of GE's plastics business, of which industrial diamonds were a part. That's why, says Russell, Hiner met in September, 1991, in London with top De Beers executives. GE denies that this specific meeting took place. Hiner, who wouldn't comment for this story, earlier called Russell's accusations "groundless" and "ridiculous."

BIG CUSTOMERS. De Beers announced list-price increases of 12% to 15% on industrial diamonds effective early this year. While GE won't confirm it, customers say GE announced similar hikes at about the same time (chart). Yet the price of man-made industrial diamonds has declined steadily since they came on the market 35 years ago, note customers and competitors. Moreover, an increase this year seemed odd to many in the industry, given weak demand in oil drilling and heavy manufacturing. Both are big customers for the diamonds. One smaller rival called the price hikes "inexplicable."

GE argues that nothing untoward happened between it and De Beers, and that there can be good reasons for meeting with competitors. However, it appears such meetings were rare in the past. E. Louis Kapernaros, general manager of GE's diamond business from 1970 to 1986, says he had one meeting with De Beers. Kapernaros, who takes care to note that he's not casting aspersions on Hiner, says that hispredecessor had no meetings with De Beers during his tenure, and that as far as he knows, the only other GE officials who did so were lawyers.

For its part, whatever the subject of a given meeting, De Beers must be careful where it does business to avoid becoming subject to U.S. antitrust regulation. Despite its protests to the contrary, the South African company is widely seen to exercise cartel control over the natural diamond gemstone business. Through its London-based Central Selling Organisation, it controls the marketing and distribution of an estimated 85% of the world's gem-diamond sales. Moreover, in 1976 it pleaded no contest to charges that its Irish industrial diamond unit violated U.S. antitrust law.

That's the last time any of De Beers' businesses have run afoul of U.S. antitrust enforcers. A source familiar with De Beers' legal situation, however, notes that ever since the U.S. Supreme Court in the mid-1940s dismissed a U.S. antitrust action against the company, "DeBeers has been terribly careful to do nothing that would give it a presence in the U.S." De Beers strongly denies Russell's charges of price-fixing, calling the industrial diamond business "fiercely competitive."

Russell also has charged that Hiner squelched his plan to get GE into the gemstone market because it would upset De Beers. Since 1970, GE has been able to make gemstones, although it says the process is too costly to be economically justifiable. But Russell claims that new technology makes it possible to produce gemstones profitably. He says that he and others at General Electric met with members of the Swarovski family, Austrian jewelry retailers, to discuss setting up a venture to sell large blue artificial gems. The Swarovskis refuse to comment.

Russell's claim, which GE denies, isn't preposterous. Japan's Sumitomo Electric Industries Ltd., for instance, makes some large crystals that sometimes find their way into the gem market, say sources in the diamond business. But Kapernaros and others are skeptical. It's also not at all clear this would be a sensible business decision, they say, even if it may be technically possible.

Russell's long list of charges also includes allegations that the company improperly covered some expenses run up by employees. His suit contends, for instance, that one manager at the GES annual sales meeting in 1990 "caused approximately $5,000 in damages to a hotel by getting drunk, tossing beer bottles through windows, and punching holes in walls." When Russell reported the incident to a superior, the suit says, he was told not to be concerned with the $5,000, since earlier sales meetings resulted in damages many times that amount. GE denies Russell's account.

Such stories, while sensational, are less significant than Russell's allegations of GE's anticompetitive practices. Outsiders say GE has aggressively defended its diamond business. Mahlon D. Dennis, a former GE employee who runs a small synthetic-diamond company in Houston, says he stays out of saw-grade diamonds because GE and De Beers "would cave my head in." But a feared competitor and an antitrust violator are hardly one and the same thing.

A DAMNING TALE. Can Russell tell the difference? According to GE, Russell's job performance began to decline soon after his promotion to vice-president in February, 1990. "I fully realize the bad miss we had in 1990," Russell wrote to Hiner after his incentive pay was reduced for that year. This cut, GE claims, reflected a poor performance, which it says even now is showing up in the 80 layoffs announced at GES in June. Profits at the unit skidded from an above-par $70 million in 1989 to just $39 million in 1991, the company says.

GE's human resources chief, Senior Vice-President Jack O. Peiffer, tells a tale in an affidavit which, if true, would be damning: that problems between Russell and his staff got so bad that Peiffer was advised of a "palace revolt." In early 1991, GE enlisted an industrial psychologist, Bradford D. Smart, to calm the situation. In court, GE filed pages of vituperative anonymous quotes made to Smart about Russell. Referring to the Smart report, Peiffer's affidavit states: "Mr. Russell was viewed by his subordinates as being untrustworthy, insecure, paranoid, indecisive, inconsistent, a poor communicator, and unproductive."

In addition, says Peiffer's affidavit, Russell botched two presentations to Welch and other top GE executives. Peiffer, who conducted Russell's exit interview, contends that Russell complained of no unethical or illegal practices or violations of company policies, apart from a complaint over an expense report. He cites, too, a February, 1990, certification by Russell that he was not aware of any violations of GE's policy requiring compliance with antitrust laws. Russell counters that most of the misdeeds he recounts took place after February, 1990.

DISSENSION. Not surprisingly, Russell gives the story a different spin. Some of GE's countercharges he considers laughable. Russell says that GE uses only some of Smart's findings, and that in fact Smart was satisfied with Russell's management. Smart himself was not available for comment. Although there's little question there were problems between Russell and some of his staff, he maintains the negative comments came from just three individuals who had clashed with him earlier over his insistence on proper business practices.

Russell contends he was making his budget the day he was fired and that earnings were down in 1991 because Hiner had loaded Russell's unit with excessive overhead charges. Russell says his incentive pay was reduced not because of his unit's performance but because of problems at the Plastics Div., which Hiner was running. Hiner, too, he notes, took an incentive pay cut. That he blew presentations to Welch is a "fabrication," says Russell.

But if Russell was raising his voice in protest, why would he be so shocked that GE responded by firing him? Russell answers that he thought he was protected by his officer status. But some sources wonder if Russell would have brought his case if he had gotten a better severance package. Because his termination becomes effective a few months before his 55th birthday, Russell won't get the same pension and insurance benefits as he would otherwise. He nonetheless feels that wouldn't have made much difference. "I really was appalled by" GE's conduct, he says.

That's not the issue the grand jury will consider. A Justice Dept. lawyer said on July 13 that the probe was still in its "fairly early" stages. It will attempt to determine whether Russell is a disgruntled employee maligning his former company or a wronged executive courageously taking his story public.RUSSELL VS. GENERAL ELECTRIC

Former GE Vice-President Edward J. Russell has sued General Electric in federal

court in Cincinnati, charging that the company fired him for protesting illegal

or unethical corporate actions. Here are his key charges, along with GE's

responses:

PRICE-FIXING GE concedes that during the period 1989-91, Glen Hiner, then

Russell's boss and head of GE Plastics, met with De Beers personnel. Russell

alleges that the purpose was to fix prices for industrial diamonds. Both

companies did raise their prices in early 1992, despite a worldwide recession.